Prudent Risk Management Is The Only True Edge In TRADING

[ironchef]

have you read Minervini "trade like a Stock Market Wizard" ?

Chapter 13 is on Risk management and fairly interesting and relates to PRM..

The first think that needs to be discussed is compounding.Its a huge part of being a successful trader,and also a large double edge sword.Simply put,if you are compounding your account,you better control your drawdowns...

Simple illustration...2 out of 3 trades make 50%,one loses 50 percent...Order doesnt matter,and as you can see,the return is only 12.5% compounded as opposed to a naive 50% guestimate..That big drawdown is a crusher..

More to the point,if you can accurately predict your hit rate,there is an optimal risk to reward for your given hit rate...Again,I am talking with compounding

Example..50% hit rate, 2 to 1 gain/loss ratio, the optimal profit target is 48% with a stop of 24%.That would produce an 80.04% return after 10 trades..

If your hit rate drops to 40%,y0u would lose 7.55% with that given set of parameters.Massive difference,so you can see how important being accurate regarding Winning percntage is.

And FWIW, with a 40% winning percentage,the optimal 2-1 profit target vs Stop is 20% and 10% which nets you 10.2 percent compounded after 10 trades..

Theres more too it,but its a good start

Thanks.

I need to think about this carefully because my options win rate is only about 30% but I don't compound. On the other hand, if I ever find a winning day trading method, I will compound and this is very relevant.

 

[savoir]

You must know, otherwise why did you say stop loss is a poor way to manage risk and R:R ratios are a joke? You must know something better???

I am not arguing with you, just eager to find out if there are better ways.

You asked what should you do. Lacking any details, I don’t know what you should do. I didn’t take your post as being argumentative and I would like to be responsive to your question but I’m not sure how. Here is my attempt.

I know you trade stocks intraday. I trade stocks for longer cycles. I stated that a stop loss is a poor way of managing risk. But for stocks, since I don’t continuously monitor my positions, I use stops and consider it a cost of doing business.

For short-term trading I use stock index futures that I monitor continuously, and using a stop loss to manage risk makes no sense. There is one exception and that is when the market is moving faster than it is possible for my senses to keep up.

I have been questioned by newbies and seasoned losers about my view and I always answer the same: You have elected to spend your time in front of the screens to monitor minute to minute and yet you sit there watching the market move to your stop loss to take you out of a trade. Why bother? Go swing trade stocks and do something more useful with your time.

Of course we all know the real reason for the use of stop losses. It is not to protect people from the market but to protect people from themselves. People can’t be trusted or they don’t know to do what is necessary when it conflicts with what they hope for, want or expect.

Regarding R:R ratios being a joke, the post above referencing a chapter in a book illustrates it as well as I would be able to. I know the post was serious, and that makes it funnier, but I am loathe to explain a joke to a person who doesn’t get the funny part. Just think about the assumptions made in order to keep the math tidy. Garbage in, garbage out.

 

[ironchef]

You asked what should you do. Lacking any details, I don’t know what you should do. I didn’t take your post as being argumentative and I would like to be responsive to your question but I’m not sure how. Here is my attempt.

I know you trade stocks intraday. I trade stocks for longer cycles. I stated that a stop loss is a poor way of managing risk. But for stocks, since I don’t continuously monitor my positions, I use stops and consider it a cost of doing business.

For short-term trading I use stock index futures that I monitor continuously, and using a stop loss to manage risk makes no sense. There is one exception and that is when the market is moving faster than it is possible for my senses to keep up.

I have been questioned by newbies and seasoned losers about my view and I always answer the same: You have elected to spend your time in front of the screens to monitor minute to minute and yet you sit there watching the market move to your stop loss to take you out of a trade. Why bother? Go swing trade stocks and do something more useful with your time.

Of course we all know the real reason for the use of stop losses. It is not to protect people from the market but to protect people from themselves. People can’t be trusted or they don’t know to do what is necessary when it conflicts with what they hope for, want or expect.

Regarding R:R ratios being a joke, the post above referencing a chapter in a book illustrates it as well as I would be able to. I know the post was serious, and that makes it funnier, but I am loathe to explain a joke to a person who doesn’t get the funny part. Just think about the assumptions made in order to keep the math tidy. Garbage in, garbage out.

Thanks for your answers.

I trade two different instruments. Options since 2013 and since early this year, experimenting with day trading stocks, a new "trick" for this old dog.

For options, I only go long, calls or puts depending on my opinion, the premium is my stop, R:R is usually a 10X potential. Positive expectancy since 2014. By positive expectancy I mean 10 year CAGR is a few % better than 10 year QQQ CAGR.

For day trading, I am a noob. Don't have a hard stop, basically stop loss is based on what you guys call "price action"? No R:R since I am trend following and don't know how to set a R:R yet. So far, three weeks of live trades with reduced size has positive expectancy.

Do you have any suggestions how i can improve my day trading, i.e., stop loss and R:R?

 

[savoir]

***
Do you have any suggestions how i can improve my day trading, i.e., stop loss and R:R?

I have no suggestions. Day trading stocks isn’t my thing. It used to be my thing when the market structure was highly favorable for day trading stocks. That was back in the late 1990s before decimalization.

Now you have dark pools and sub-penny trading. Day trading stocks looks to me to be a difficult grind. Yet you seem to have organized yourself to make a go of it. Hats off to you.

 

[taowave]

Very odd post..

Stops suck,but you use them as you are a swing trader?? Of course they are a cost of doing business ..So is health insurance..

My post is one of the few posts ( maybe someone discussed Kelly)on this thread which actually puts some numbers behind the madness.
Of course one must guesstimate Hit Rate,but there is no way around it.

Ild love to hear your risk management technique,as you are the only swing trader I have ever heard state that stops are a poor way of managing risk..

As a derivatives guy,I am going to assume you aren't bringing option hedges into the discussion..

You asked what should you do. Lacking any details, I don’t know what you should do. I didn’t take your post as being argumentative and I would like to be responsive to your question but I’m not sure how. Here is my attempt.

I know you trade stocks intraday. I trade stocks for longer cycles. I stated that a stop loss is a poor way of managing risk. But for stocks, since I don’t continuously monitor my positions, I use stops and consider it a cost of doing business.

I get your view on wanting precious time day trading and staring at screens.But that has nothing to do with stops.

For short-term trading I use stock index futures that I monitor continuously, and using a stop loss to manage risk makes no sense. There is one exception and that is when the market is moving faster than it is possible for my senses to keep up.

I have been questioned by newbies and seasoned losers about my view and I always answer the same: You have elected to spend your time in front of the screens to monitor minute to minute and yet you sit there watching the market move to your stop loss to take you out of a trade. Why bother? Go swing trade stocks and do something more useful with your time.

Of course we all know the real reason for the use of stop losses. It is not to protect people from the market but to protect people from themselves. People can’t be trusted or they don’t know to do what is necessary when it conflicts with what they hope for, want or expect.

Regarding R:R ratios being a joke, the post above referencing a chapter in a book illustrates it as well as I would be able to. I know the post was serious, and that makes it funnier, but I am loathe to explain a joke to a person who doesn’t get the funny part. Just think about the assumptions made in order to keep the math tidy. Garbage in, garbage out.

 

[savoir]

Very odd post..

Stops suck,but you use them as you are a swing trader?? Of course they are a cost of doing business ..So is health insurance..

My post is one of the few posts ( maybe someone discussed Kelly)on this thread which actually puts some numbers behind the madness.
Of course one must guesstimate Hit Rate,but there is no way around it.

Ild love to hear your risk management technique,as you are the only swing trader I have ever heard state that stops are a poor way of managing risk..

As a derivatives guy,I am going to assume you aren't bringing option hedges into the discussion..

I thought my post was unambiguous. You must have skipped over the part where I said I don’t use stop losses for futures and my rationale.

I also gave my rationale for using stop losses in my stock trading—I cannot monitor my positions as I do for futures. Relying on a stop loss is a poor way of managing risk but still better than leaving an unmonitored position without one. I don’t use options.

It’s good to always have a failsafe. For futures I limit the size of the account and I use more than one. From experience I know that parking money in a futures account is not a good idea.

Guesstimating hit rates is a joke to me. What exactly is a hit? All trades after entry go into both loss and profit, not necessarily in that order and not necessarily just once. It is overly simplistic to think of a series of actions as discrete trades to tally up and determine a batting average, especially when almost always in.

I’m referring to trading futures in the above paragraph and I’m speaking for myself only, of course.

 

[Jzwu2017]

I use stops to protect from myself. I tend to hold losers forever and add to losers if possible. It’s simply human psychology.

If I don’t have a clear stop price I just use 1% loss rule. Otherwise, I use whatever clear stop price point as I see.

 

[taowave]

So you believe the Kelly/Modified Formula is a joke??

Still do not understand why a stop loss is a poor way of managing risk ? As a value investor I totally get it,but not for swing trading...

Whats your preferred method of "risk management"..??

I thought my post was unambiguous. You must have skipped over the part where I said I don’t use stop losses for futures and my rationale.

I also gave my rationale for using stop losses in my stock trading—I cannot monitor my positions as I do for futures. Relying on a stop loss is a poor way of managing risk but still better than leaving an unmonitored position without one. I don’t use options.

It’s good to always have a failsafe. For futures I limit the size of the account and I use more than one. From experience I know that parking money in a futures account is not a good idea.

Guesstimating hit rates is a joke to me. What exactly is a hit? All trades after entry go into both loss and profit, not necessarily in that order and not necessarily just once. It is overly simplistic to think of a series of actions as discrete trades to tally up and determine a batting average, especially when almost always in.

I’m referring to trading futures in the above paragraph and I’m speaking for myself only, of course.

I thought my post was unambiguous. You must have skipped over the part where I said I don’t use stop losses for futures and my rationale.

I also gave my rationale for using stop losses in my stock trading—I cannot monitor my positions as I do for futures. Relying on a stop loss is a poor way of managing risk but still better than leaving an unmonitored position without one. I don’t use options.

It’s good to always have a failsafe. For futures I limit the size of the account and I use more than one. From experience I know that parking money in a futures account is not a good idea.

Guesstimating hit rates is a joke to me. What exactly is a hit? All trades after entry go into both loss and profit, not necessarily in that order and not necessarily just once. It is overly simplistic to think of a series of actions as discrete trades to tally up and determine a batting average, especially when almost always in.

I’m referring to trading futures in the above paragraph and I’m speaking for myself only, of course.

 

[savoir]

So you believe the Kelly/Modified Formula is a joke??

It’s a formula. GIGO

Still do not understand why a stop loss is a poor way of managing risk ? As a value investor I totally get it,but not for swing trading...

I explained it a couple of ways. I’m out of words.

Whats your preferred method of "risk management"..??

Already answered. Don’t over leverage.

 

[taowave]

OK,you are an investor..no need to explain more

It’s a formula. GIGO



I explained it a couple of ways. I’m out of words.



Already answered. Don’t over leverage.